What Are The Rules For Roth IRA Withdrawals?

The tax code is set up to provide certain benefits to those saving for retirement. With a traditional IRA or 401(k), you get the break up front when the money is contributed. With Roth IRAs, the tax advantage happens on the withdrawal. But you should be aware of Roth IRA withdrawal rules to avoid running afoul of the IRS.

Should I Withdraw From My Roth IRA?

You can withdraw from your Roth IRA to cover any number of living expenses, but you’ll have to pay income tax on nearly every withdrawal taken prior to retirement age. In many circumstances, you may be subject to an additional early withdrawal penalty as well. There are a few situations where you can take money from your Roth IRA early, but those are specific and limited. Before making any decisions, we recommend consulting a tax professional for individualized advice.

Withdrawing Before Reaching 59½ Years Old

Because retirement accounts are designed to fund your golden years, the government doesn’t want you withdrawing from the funds before age 59½. Doing so generally results in a 10% tax penalty on top of being recognized as part of your regular income.

In order to take any distribution without a tax penalty, the IRA has to be at least 5 years old. Even then, there are only a couple of situations in which income withdrawn from your Roth IRA before age 59½ aren’t taxed:

• You’re taking the distribution because you’re disabled (as defined by a physician).
• The distribution was made to a beneficiary after the original account holder passed.
• You use the distribution to buy, build or rebuild a first home for yourself or certain close relatives including spouses, children or grandchildren. This particular exception has a $10,000 lifetime limit. A first-time home buyer is defined as someone who has no ownership interest in a primary home within 2 years leading up to the acquisition.

In other situations, you may be able to avoid the additional 10% tax penalty also associated with early withdrawal if any of the following apply:

• You’re totally and permanently disabled.
• You have a diagnosed terminal illness.
• You are listed as the beneficiary of an IRA for someone who has passed.
• Distribution payments are considered substantially equal.
• Unreimbursed medical expenses make up more than 7.5% of your adjusted gross income.
• You pay medical insurance premiums while unemployed.
• The distribution is considered corrective.
• You make the withdrawal for qualified higher education expenses.
• The distribution is caused by an IRS levy of your retirement plan.
• You take a distribution as a qualified military reservist.
• The distribution was for a qualified birth or adoption.
• The distribution is taken in the aftermath of a qualified disaster or disaster recovery.

Withdrawing Within 5 Years

You cannot withdraw tax-free from your Roth IRA within 5 years of setting it up regardless of your age. If you do, you generally have to pay taxes on the withdrawal. However, you won’t have to pay a 10% tax penalty if you meet one of the exceptions listed above.

Withdrawal Rules For Roth Conversions

When you convert from a traditional IRA or 401(k) to a Roth IRA, you’ll pay taxes at the time of the conversion. The idea here is that this would be the same as the tax payment on contributions if you had set it up as a Roth initially. Income rolled over from one Roth IRA into another isn’t subject to income tax.

No matter whether doing a conversion or a rollover, your funds must be added to the new account within 60 days to avoid a 10% tax penalty.

What To Know About Inherited Roth IRAs

An inherited IRA is one that you become the beneficiary of after the passing of its holder. You’ll have different options depending on whether you’re a spouse or another beneficiary. You should speak with a financial advisor about your individual situation.

Withdrawals of contributions to an inherited account are tax-free. In addition, most earnings withdrawn from an inherited Roth IRA are tax-free. The exception would be if the earnings are withdrawn from the IRA account that’s less than 5 years old when the withdrawal is made.

Roth IRAs: Everything Else You Need To Know

When dealing with IRA options, there is a plethora of information you need to know to evaluate what’s right for you. It never hurts to speak with a financial advisor about your unique situation, but here are some considerations:

Backdoor Roth IRAs: Backdoor Roth IRAs get around the income limits set by the IRS for contributing to a Roth IRA. It depends on your filing status, but as an example, if you’re single, you can’t contribute to a Roth IRA with an income above $161,000. You get around this by contributing money you’ve already paid taxes on to a traditional IRA and then converting that to a Roth IRA. The idea being that if taxes go up, you paid at a lower rate.

Roth IRA versus Traditional IRA: The difference between a Roth IRA and a traditional IRA is the way taxes are handled. With a Roth IRA, you pay the taxes when you make a contribution. With a traditional IRA, taxes are paid when the money is withdrawn.

IRA versus 401(k): An IRA is a retirement account set up by individuals. On the other hand, 401(k)s are set up by companies on behalf of their employees. You may have some discretion in terms of the aggressiveness of the investment strategy and some direction in terms of allocation. But an IRA offers more control because you can pick your investments at a more granular level.

Rolling Over 401(k) to Roth IRA: If you’re interested, you can roll over a 401(k) into an IRA. Whether you’re going to have to pay taxes to do so depends on whether the existing 401(k) was a Roth 401(k) prior to conversion. Roth 401(k)s wouldn’t require tax payments, but traditional 401(k)s would.

The Bottom Line: Knowledge Is Power With A Roth IRA

Withdrawing from a Roth IRA may make sense in certain situations, but withdrawing funds before age 59½ or before you’ve had the IRA for 5 years means it’s considered taxable income, and could incur substantial tax penalties. When you convert another type of account to a Roth IRA, the same rules apply as if you started contributing from scratch.

You should do your research and feel free to consult a financial advisor to pick the retirement option that’s best for you. The Rocket Money^SM app allows you to get your full financial outlook so that you can set yourself on the path to the retirement you want.